Microsoft Needs to Be Aware
Of IBM's Mistakes in the '80s

The question sounds perverse. The software giant's multibillionaire chairman, Bill Gates, lately has been lauded for deciding to funnel some of the company's cash into
Comcast
's cable business, WebTV Networks and deals with television producers to make their shows interactive. Despite big stock buybacks, some $9 billion in cash had piled up by March from Microsoft's outlandishly profitable computer-software business.

By investing in these companies, fans say, Mr. Gates ensures that Microsoft will have a role when people use their TV cables or the sets themselves in the interconnected world of the future -- for instance, to surf the Internet.

And if Mr. Gates is wrong about the prospects for interactive TV -- as he and his research visionary, Nathan Myhrvold, were a few years ago when they prematurely spent heavily to develop software for set-top boxes -- who cares? Microsoft's cash has nearly doubled since mid-1995, and its current operations throw off cash flow of about $4 billion a year.

On the whole, "Microsoft's judgment of what to develop has been very good," says money manager Martin Sosnoff of Atalanta/Sosnoff Capital. Maybe because of that, shareholders don't feel the need to ask rigorous questions about what return Microsoft expects on its investments, says Harvey Bateman of Sirach Capital Management.

But there is a risk in having so much money that the ordinary disciplines go out the window. In the 1980s,
International Business Machines
, as dominant then in mainframe computers as Microsoft is in software now, managed to squander its excess cash on real estate and factories that were soon obsolete.

In those days, IBM's sheer wealth masked errors that eventually undermined it. Similarly, Microsoft's prosperity makes people forget its flops, such as its 1995 "Bob" cartoon characters, designed to aid computer users. Microsoft has spent $8 billion to $10 billion on research and development since its 1975 inception, to get fiscal 1997's projected sales of about $11 billion.

The real lesson from IBM, says Microsoft's treasurer, Greg Maffei, is that "arguably it didn't invest enough" back then, particularly in the growing market for personal computers. "We need to be a broad technology company and invest broadly" in strategically related areas, Mr. Maffei says. Microsoft's previous equity investments of about $1 billion in other companies' Internet and software ventures since 1994 have been hugely successful, he adds.

Indeed, the software titan seems unlikely to repeat one earlier error. Two years ago, Microsoft's stock lost one-fifth of its value because of little
Netscape Communications
' prominence on the Internet. Since early 1996, thanks to Microsoft's hundreds of millions -- some say billions -- spent on Internet products and ventures, the stock has gone from the mid-40s to 127 1/2 Friday.

This despite the fact that Microsoft's browser is free of charge and analysts can't compute how much money the company makes from products that access the Internet. Microsoft's stock price today "assumes very few risks in our future," Mr. Maffei remarks.

And what will Microsoft get from the $1 billion it is paying for 11.5% of Comcast? Until Comcast's stock goes up, it will cost Microsoft two cents a share in annual profit to move cash out of short-term securities and into Comcast stock.

But Microsoft isn't just after a good stock. Its real payoff will come as Comcast's 4.3 million customers, and those of other cable companies, acquire set-top boxes and modems that can be used to bring data through TV cables to computers. Microsoft then will be able to sell software and perhaps bring more traffic, and advertising dollars, to its Internet ventures.

"The real payoff won't come for five or 10 years," says Mr. Maffei. Microsoft, he notes, began investing in Windows in 1984: "It didn't pay off till 1990. Since then, it has paid off pretty well."

Some cable executives expect modems to be in 5% to 10% of homes where they're available in the first year after rollout, and in 20% or more within five years of their introduction. At least Comcast isn't a risky stock, says David Simons of Digital Video Investments. WebTV, a venture that Microsoft opted to buy in April for $425 million, "could go to zero" if TV interactivity doesn't pan out, he says.

Though cable stocks have been in the doghouse in recent years, Microsoft didn't buy Comcast at the bottom.

At their low point last October, cable stocks traded at around 6.5 times expected 1997 cash flow, says analyst Doug Shapiro of Deutsche Morgan Grenfell. Though he likes the deal, he figures Microsoft is paying 8.9 times 1997 cash flow for Comcast, a slightly higher multiple than the
Cablevision
stock
Tele-Communications Inc.
is acquiring at what some consider a pricey level.

To launch the MSNBC cable channel last July, Microsoft found a partner,
General Electric
, whose chairman, John Welch, is known to have rigorous investment criteria. GE's NBC and Microsoft each agreed to invest $250 million over five years.

In doing so, NBC President Tom Rogers says, he had "pretty clear guideposts" and "profit criteria." Today, MSNBC has nearly 37 million subscribers, and commitments from cable operators that will put the number at 55 million by the year 2,000 -- more than enough for a cable channel to break even. The number of current viewers is said to be much smaller.

As for MSNBC's Internet offshoot, he adds, "no one knows when the ad dollars will kick in," but it is quickly building a brand name, "the critical component." IBM, which again is accumulating cash, appears to have sharpened its profit criteria. An IBM spokesman points out that acquisitions in the past two years, such as Lotus Development and Tivoli Systems, added to earnings from day one.